On Our Radar

On Our Radar

Are Stocks, Bonds Signaling a Double-Dip Recession?

Concerns about the sustainability of the economic recovery are resurfacing again as stocks have retreated, commodities such as silver and crude oil have tumbled and demand for ultra-safe U.S. Treasurys has hit the highest level of the year.

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But before you start bracing for a double-dip recession, realize that most forecasters believe the U.S. economy is just going through a soft patch and has the momentum to power through. They see a repeat downturn as an unlikely outcome in the next six to nine months, short of some major shock to the system like an oil price explosion.

“I don’t think there’s any indication the U.S. economy is backsliding,” said Gus Faucher, director of macroeconomics at Moody’s Analytics and a former Treasury Department senior economist. “I think the odds of a double-dip recession are the lowest we’ve seen in a few years, probably since we came out of the recession.”

Indicators, Markets Signal Caution

To be sure, the causes for concern are real as the U.S. economy is facing a cluster of headwinds and market metrics are reflecting that.

Bearish investors can point to a myriad of fears, everything from the end of the Fed’s $600 billion bond-buying program and turmoil in the Middle East to gloomy guidance from Cisco Systems (CSCO), a nonexistent rebound in the housing sector and fiscal messes at home and abroad (see: Greece).

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At the same time, some recent economic indicators have given Wall Street a reason to pause. The U.S. economy grew at a lethargic pace of 1.8% in the first quarter, housing starts declined 10.6% last month and manufacturing activity in New York State plunged in May to the lowest level in five months.

“There’s a lot of cross currents here,” said Marc Pado, U.S. market strategist at Cantor Fitzgerald. “Not that I think it’s going to shift the tide from slow growth to recession, but it is taking the recovery off pace so the growth has slowed.”

In response to some of those concerns, cash has shied away from riskier assets like stocks and commodities. Before rebounding on Wednesday, the Dow Jones Industrials closed at its lowest level since April 20 and is on track for its first losing month since last November.

The turbulent commodities complex has mostly retreated amid the growth worries. Crude oil landed on Tuesday at its lowest level since February and volatile silver has plunged 30% this month alone.

“Although several forward-looking indicators have worsened, this should not be a surprise since periodic setbacks are part of any economic recovery,” Bob Doll, chief equity strategist at BlackRock, wrote in a note.

The beneficiary has been the bond market, as the yield on the 10-year Treasury note, which moves in the opposite direction of the price, tumbled to levels unseen since December. Corporate America has capitalized on the demand for debt, selling $19 billion in investment-grade bonds over a two-day span this week.

On the Bright Side

Despite those market metrics and slowdown fears, the U.S. economy is expected to rebound in the second half of 2011.

There are a slew of tailwinds keeping the economy afloat, including strength in exports and growth in the manufacturing sector.

Thanks to the Fed-induced weaker greenback, U.S. exports jumped 4.6% in March to a record $172.7 billion. The month-month gain was the largest experienced in 17 years.

Manufacturing continues to expand at a healthy rate. The Institute for Supply Management’s manufacturing index slipped a bit, to 60.4 in April, but still exceeded estimates from private forecasters. Durable goods orders, which measure demand for big-ticket items like refrigerators and PCs, jumped 2.5% in March.

Quietly, employers are adding to their payroll. The U.S. has added more than 200,000 jobs in each of the past three months, highlighted by April’s gain of 244,000. Crucially, private-sector job growth has gathered momentum, with businesses adding 268,000 jobs last month -- the largest increase since February 2006.

Further, tumbling commodities will allow corporations to breathe easier, lowering input costs and boosting profit margins. The tumble in oil prices from nearly $115 a barrel in the beginning of May is likely to ease consumers’ pain at the pump, improve consumer confidence and help transportation companies like FedEx (FDX) and Carnival (CCL).

What the Experts Expect

“While we do not believe that the long-term secular uptrend in commodity prices has ended, we do think that the cooling effect could be in place for some time, which will hopefully be a positive for both economic growth and stocks,” said Doll.

A panel of 41 economists surveyed by the National Association of Business Economists lowered their 2011 GDP forecast on Monday to 2.8% from a February estimate of 3.3%. NABE sees GDP growth rising to 3.2% next year.

Moody’s Analytics is more bullish, calling for 3% growth this year and then 4% in 2012 and 2013. The private research firm forecasts the U.S. creating about 225,000 jobs a month through the rest of 2011 and then closer to 250,000 in 2012 and 300,000 in 2013.

“Business balance sheets remain very, very strong. Businesses are highly profitable, margins are good,” said Faucher. “They are hiring and they have the cash to hire more.”

History does seem to be on the bulls’ side.

The S&P 500 has rallied an average of 17% during the third year of presidential terms since 1945, three times as much as the next best year in the four-year cycle, according to S&P Equity Research. In fact, the index has closed higher 94% of the third year of the term since World War II.

That’s not to say the economic recovery can’t be derailed by some unforeseen event.

For example, economists said Congress failing to raise the U.S. debt limit and causing a financial crisis would seriously threaten the recovery -- a sentiment shared by Treasury Secretary Tim Geithner but not some deficit hawks. Likewise, an oil-price surge fueled by the unrest in the Middle East spreading to Saudi Arabia could force a double-dip.

“I think the economy does have some resiliency now,” said Faucher.

That resiliency has shown as the economy has slowed, but refused to fully succumbed to recent shocks, including the European sovereign debt crisis, the massive earthquake and tsunami in Japan and the unrest in Egypt and Libya that sent oil soaring.